Why Oil Prices Must Go Up

It may be difficult to look beyond the current pricing environment for oil, but the depletion of low-cost reserves and the increasing inability to find major new discoveries ensures a future of expensive oil.

While analyzing the short-term trajectory of oil prices is certainly important, it obscures the fact that over the long-term, oil exploration companies may struggle to bring new sources of supply online. Ed Crooks over at the FT persuasively summarizes the predicament. Crooks says that 2014 is shaping up to be the worst year in the last six decades in terms of new oil discoveries (based on preliminary data).

Worse still, last year marked the fourth year in a row in which new oil discoveries declined, the longest streak of decline since 1950. The industry did not log a single “giant” oil field. In other words, oil companies are finding it more and more difficult to make new oil discoveries as the easy stuff runs out and the harder-to-reach oil becomes tougher to develop. Related: Shale Rivals OPEC As Swing Producer

The inability to make new discoveries is not due to a lack of effort. Total global investment in oil and gas exploration grew rapidly over the last 15 years. Capital expenditures increased by almost threefold to $700 billion between 2000 and 2013, while output only increased 17 percent (see IEA chart).

Despite record levels of spending, the largest oil companies are struggling to replace their depleted reserves. BP reported a reserve replacement ratio – the volume of new reserves added to a company’s portfolio relative to the amount extracted that year – of 62 percent. Chevron reported 89 percent and Shell posted just a 26 percent reserve replacement figure. ExxonMobil and ConocoPhillips fared better, each posting more than 100 percent. Still, unless the oil majors significantly step up spending they will not only be unable to make new discoveries, but their production levels will start to fall (some of them area already seeing this begin to happen). The IEA predicts that the oil industry will need to spend $850 billion annually by the 2030s to increase production. An estimated $680 billion each year – or 80 percent of the total spending – will be necessary just to keep today’s production levels flat.

However, now that oil prices are so low, oil companies have no room to boost spending. All have plans to reduce expenditures in order to stem financial losses. But that only increases the chances of a supply crunch at some point in the future. Put another way, if the oil majors have been unable to make new oil discoveries in years when spending was on the rise, they almost certainly won’t be able to find new oil with exploration budgets slashed.

Long lead times on new oil projects mean that the dearth of discoveries in 2014 don’t have much of an effect on current oil prices, but could lead to a price spike in the 2020’s.

Not only that, but shale production is much more expensive than conventional drilling. As conventional wells decline and are replaced by shale, the average cost per barrel of oil produced will continue to rise, pushing up prices.

Moreover, with rapid decline rates, the shale revolution is expected to fade away in the 2020’s, leaving the world ever more dependent on the Middle East for oil supplies. The problem with that scenario is that the Middle East will not be able to keep up. Middle Eastern countries “need to invest today, if not yesterday” in order to meet global demand a decade from now, the International Energy Agency’s Chief Economist Fatih Birol said on the release of a report in June 2014.

In fact, half of the additional supply needed from the Middle East will have to come from a single country: Iraq. Birol reiterated those comments on February 17 at a conference in Japan, only his warnings have grown more ominous as the security situation in Iraq has deteriorated markedly since last June. “The security problems caused by Daesh (IS) and others are creating a major challenge for the new investments in the Middle East and if those investments are not made today we will not see that badly needed production growth around the 2020s,” Birol said, according to Reuters.

If Iraq fails to deliver, the world could see oil prices surge at some point in the coming decade. Despite the urgency, “the appetite for investments in the Middle East is close to zero, mainly as a result of the unpredictability of the region,” he added.

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You identify the real problem as you work through the data: politics. Venezuela, Libya, Iran and Iraq all have plenty of oil and gas that is not being efficiently exploited or shipped due to the political climate. Legal and economic issues are hampering development of fuel resources in Mexico, Brazil and Africa. Fuel subsidies in these countries and the Middle East seriously distort demand. The truth is that the world could be comfortably developing and using fossil fuels at a lower long-term cost, if governments were concentrating on regulating these industries rather than running them. Norway is a good example of a sustainable petrostate.

Lee James on February 18 2015 said:

This article is exactly as I see it. Nick says it and documents it well. A huge jump in oil prices is certainly coming.

The article leaves off with what to do. Are we resigned to unsustainable high oil prices?

Or, do we see the need to reduce the environmental, political and economic consequences of burning oil, and drastically reduce oil dependency?

I sure hope that we are not left saying, "Duh."

Ed Johnson on February 18 2015 said:

US Oil excess inventories hit another all-time record high this week at almost 420M bbls. Even though $50 oil means that a full quarter or more of US rigs have been shut down, the glut goes on. Oil prices were up 9% the last 3 days, they've pulled back 3% on these news.
Until the glut is resolved, either with production cuts (OPEC refuses) or increased consumption (unlikely as China's GDP growth slows) prices are likely to be in a $50-60 channel.
They will kill off the most inefficient and leveraged frackers, but $50 oil is still returning handsome profits to OPEC members.

Ron Wagner on February 18 2015 said:

The article comes to a wrong conclusion based on false premises.

Instead consider:

1. There is an abundance of natural gas, which is cleaner, cheaper, and more abundant worldwide. It can replace oil for any use.

2. Fracking and horizontal drilling are becoming more prevalent worldwide, and will continue to improve.

3. As Jim mentioned, most old wells and fields are still ripe for more development.

joe rice on February 18 2015 said:

Oh great..another article trying to convince us that high oil prices are good for the economy.. Whats really distorted the demand is the presence of speculaters who have been artificially gambling up a false demand since they were allowed in the markets back in 2000...Only 20% of those in the markets are real buyers...Meaning 80% are simply betters, artificially increasing a demand thats not there.Think about the hundreds of thousands of people pulling into gas stations every minute nation wide... Every single one of them saves about 30 dollars a fillup... Instead of that money being funneled up to Wallstreet speculaters like its been the last 10 years, it now back in the pockets of the middle class.... If we really want to stabilize oil prices and let true supply and demand dictate the price, ban speculation and only open the markets to real buyers.....High oil is bad for Wallstreet, and good for the 99% of us not making money on random oil bets..

James Kearns on February 18 2015 said:

How and when will LENR's affect oil usage and prices?

Bryan on February 19 2015 said:

Looking at current gas prices now at 2 bucks a gallon I'm saving 20 bucks a week vs 3 bucks a gallon for my truck. I'm all for 100 bucks a barrel. It keeps people working and 20 a week isn't gonna save the world but will save millions of jobs. And if your like some who have a fuel efficient civic, your savings are more likely 12 bucks a week.

For example, my truck has a 20 gallon tank, 1 dollar per gallon savings is 20 a fill up once a week. A Honda civic has a 12 gallon tank, 1 dollar per gallon savings is 12 bucks a fill up per week.

So $32 a week in savings, I will never notice. It's not a significant amount. I'd save so much more by ending our families movie night and going out to eat. That's about 150 - 200 a week for a family of four.

So saying cheap gas is gonna save us all is pure bs. I'm more worried about the massive job losses as a result from cheap gas.

Tmoan Bickens on February 19 2015 said:

great artcile, april 1 2015 oil price will go over $100 book it!

david zabolio on February 25 2015 said:

I'm not sure what planet Tmoan Bickens is living on but it sure isn't earth.................

Corey on March 03 2015 said:

Bryan. Totally right.

So many people are dumb and think that saving money at the pumps is big savings.

All you people that think it is, let me ask has prices gone down in food? No. Has prices gone down in vehicles? No. Has prices gone down say at Disneyland? Nope they just went up. So what does the economy do when oil
Prices go down they take the money out of your pocket in groceries,vehicles, and entertainment. They said a person would save over 900 dollars in a year. What the heck is that in a year. That's nothing. Has home
Prices gone down too? Nope
So that means that's 900 you saved does nothing for you because once you pay for something there will be no more savings coming in so the what do you so called smart Americans do to pay for those things. Not
Much considering oil companies aren't working as much, and not many other jobs around. Trust me higher prices are good because people spend then because they are working.

Ricky on March 05 2015 said:

Oil companies still have plenty to cut in order to survive and strive later.
If you are not in the O&G sector and not a millionaire do you ever had the chance to
1. Take a private plane?
2. Often take business class plane without the need to be upgraded by the airline.
3. Stayed at 5 star hotel.
4. Getting high pay and increments with the same years of experience compared to other sectors.
5. Taking resources without the need to manufacture or purchase the raw materials.
6. Getting lucrative packages when travelling / in expat programs.
and plenty more.